Analysis on the Hedging Effects of the Introduction of Won-Yen Currency Futures Contract
Won-Cheol Yun
Despite of regional closeness and active trading between Korea and Japan, there is little empirical analysis on the foreign exchange risk of Korean won and Japanese yen. Recently, the Korea Exchange (KRX) has introduced a Japanese yen currency futures contract. The main objective of this study is to examine the hedging performance of this foreign exchange hedging tool. This study sets up a theoretical framework for two hedging scenarios for yen-denominated investment with direct and cross hedge types. According to the simulation results, the 1:1 naive and the minimum variance hedge strategies using OLS and ECM outperform no-hedge strategy. With respect to risk reduction, the minimum variance hedge is considered to be superior to the 1:1 naive hedge. More importantly, the hedging performance of direct hedge strategy proves to be even better than that of cross hedge strategies. The differences in the hedging performances between direct and cross hedges would be regarded as the effects of introducing Japanese yen currency futures contract.